Darden Restaurants - Wait For A Further Sell-Off Before Picking Up Shares

Shares of Darden Restaurants (NYSE:DRI) ended Tuesday's trading session with losses of 9.6%. The company issued disappointing preliminary second quarter results before the market open. The poor results, prompted the company in lowering its full year outlook.

Preliminary Second Quarter Results

Darden Restaurants reported that it expects diluted earnings per share of $0.25-$0.26 for its second quarter of its fiscal 2013. In the quarter ending last week, the company took some charges. The acquisition of Yard House will negatively impact earnings by five cents per share. Hurricane Sandy will have an adverse effect of one cent on earnings per share.

Earnings fell short of analysts expectations of $0.47 per share, and last year's earnings of $0.41 per share. Definitive earnings will be released on the 20th of December of this year.

Disappointing earnings are driven by a 2.7% fall in same restaurant sales for the quarter in the main Red Lobster, Olive Garden and LongHorn Steakhouse business. The specialty restaurant group will report same-restaurant sales of plus 0.7%.

CEO and Chairman Clarence Otis commented on the disappointing preliminary results, "Our second quarter is an especially value sensitive time of year, and this year's promotional offers were largely consistent in nature what we've promoted successfully in the past. These promotions did not resonate with financially stretched consumers as well as newer promotion from competitors. Our disappointing results for the quarter point to the need for bolder changes in the promotional approach at our three large brands."

Outlook

On the back of the disappointing second quarter results, Darden has lowered its full year outlook. Total sales growth is expected to come in between 7.5% and 8.5% on the back of a 1% same restaurant sales decline from the company's core business. Total sales growth will be driven by the addition of Yard House as well as 100 net restaurant openings during the year. At the presentation of the first quarter results, Darden guided for total sales growth of 9 to 10%.

Full year diluted earnings per share are expected to come in between $3.29 and $3.49 for the year, which includes 8-10 cents of transaction costs related to Yard House. Earlier, Darden Restaurants guided for earnings growth of 5-9%, implying annual earnings per share of $3.76-$3.90.

CEO Otis furthermore commented, "We are being cautious about our sales and earnings forecasts for the full year. Our outlook for the year also reflects the potential impact, though difficult to measure, of recent negative media coverage that focused on Darden within the full-service segment and how we might accommodate healthcare reform."

Valuation

Darden Restaurants ended its first quarter of its fiscal 2013 with $51.5 million in cash and equivalents. The company operates with $2.10 billion in short and long term debt, for a net debt position a little over $2 billion.

For the full year of its fiscal 2013, Darden expects revenues to come in between $8.6 and $8.7 billion. Full year earnings could come in between roughly $430 million and $460 million, or around $3.39 per diluted share, at the midpoint of the guided range.

Factoring in Tuesday's declines, the market values Darden at $6.1 billion. This values the firm at 0.7 times annual revenues and 13-14 times fiscal 2013s annual earnings.

Darden currently pays a quarterly dividend of $0.50 per share, for an annual dividend yield of 4.2%.

Some Historical Perspective

Year to date, shares of Darden Restaurants have risen a mere 3%. Shares started the year around the mid-forties and rose to highs of $57 in September. Shares are currently exchanging hands around $47 per share.

Between its fiscal 2009 and 2013, Darden grew annual revenues by roughly 20% from $7.2 billion in 2009 to $8.7 billion this year. Earnings rose in a similar fashion to an expected $450 million this year.

Investment Thesis

At the presentation of the first quarter results investors were favorably surprised that food costs remained relatively under control, based on seafood deflation. In hindsight, the first warning signs emerged. Red Lobster, which is the largest division, focused more on value-oriented offerings as consumers ran away to cheaper competitors.

At the time I argued that there was little room for further upside, with shares trading around $56 per share. Shares have fallen some 15% from that point in time as conditions have quickly deteriorated in recent months. The negative media coverage regarding the healthcare reform on the restaurant business continues to put pressure on chains like those operated by Darden.

While the valuation is more appealing at the moment, I would hold off picking up some shares until they reach the $35-$40 trading range.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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